You are on page 1of 68

A PROJECT REPORT ON

COMMODITY MARKETS

SUBMITTED BY

MR. NISHIT MUKESH DHOLAKIA

FOR THE DEGREE OF


THE BACHELOR OF MANAGEMENT STUDIES

UNIVERSITY OF MUMBAI

UNDER THE GUIDANCE OF

PROF. KINNARRY THAKKER

S.I.E.S. COLLEGE OF SCIENCE, ARTS AND COMMERCE


SION (W), MUMBAI 400022

ACADEMIC YEAR 2007-2008

DECLARATION
I, Mr. Nishit Mukesh Dholakia studying in the Third Year of
Bachelor of Management Studies course in the academic year 2007-2008 at
S.I.E.S. College of Science, Arts and Commerce, Sion (West), hereby
declare that I have completed the project titled COMMODITY
MARKETS, as a part of the course requirement of Bachelor of
Management Studies of University of Mumbai.
I further declare that the information presented in this project is true
and original to the best of my knowledge.

Date:
Place: Mumbai

Mr. Nishit Mukesh Dholakia

CERTIFICATE

I, Prof Kinnarry Thakkar hereby certify that Mr. Nishit Mukesh Dholakia studying in
the Third Year of Bachelor of Management Studies course in the academic year 2007-2008
at S.I.E.S. College of Science, Arts and Commerce, Sion (West), hereby declare that I have
completed the project titled Commodity markets, under my guidance in the academic
year 2007-2008.
I further declare that the information presented in this project is true and original to the best
of my knowledge.

Date:
Place: Mumbai
Prof Kinnarry Thakkar
College Seal

PRINCIPAL

ACKNOWLEDGEMENT

I would like to express my gratitude and sincere thanks to my Project Guide Prof
Kinnarry Thakkar, S.I.E.S College of Science, Arts and Commerce for instilling confidence
in me to carry out this study and extending valuable guidance and encouragement from
time to time, without which it would not have been possible to undertake and complete this
project.
I also wish to extend my appreciation to the management and staff of my college
especially the chief co-ordinator of BMS Mr. Rajkumar Bagadia and our principal
Dr. Harsha Mehta, for their kind co-ordination and support. Last but not the least my
colleagues for their valuable comments and suggestions for making this a cherishable
experience for me.

Nishit Mukesh Dholakia


4

Executive summary
Commodity markets are the basic necessities of everybody but due to the modern
technology, globalization, and liberalization, commodity markets can go across the world
with regards to commodity trading. Commodity markets are maturing day by day in
todays market. Commodity market is an important constituent of the financial markets
of any country. Commodities are amongst the oldest market of the world. Commodities
can be classified into gold, silver, nickel, zinc, copper and so on. There are so many
commodities emerging at a very quick pace.
Investing in commodities is a very good option, but there are many risks involved in it as
involved in any investment. In order to avoid such risks the investor should carefully
examine the market before investing anything. The investor should keep regular check of
the market as the market fluctuates anytime so he should be careful about it as, if he
losses concentration he can incur a big lose. So investing in commodities is risky but
useful. There are many commodities for investing but the most likely ones are Gold,
Silver, soybeans castor oil and so on.
The future of commodities is very bright. Demand is increasing rapidly. Demand for a
wide variety of commodities covering food, fibre, metals and energy is certain to expand.
Competition from imports is increasing, Whether or not domestic producers like it, the
competition from imported commodities is inevitable. Competition is now driving
smaller players to explore opportunities for merger. There are risks involved because of
the increasing demand and pressure from the importers so the investors should invest by
emerging with an experienced broker who has every idea about the market happenings.
It is this emerging scenario that the investors must gear themselves to face.
HERE IT IS THE QUESTION OF INVESTING MONEY AND WHERE MONEY IS
INVOLVED RISKS TEND TO FOLLOW THEM.

INDEX
Content

Particulars

Page numbers

no
1]

Introduction

7 10

2]

Objective, Methodology &

11 - 12

Limitations
3]

Need for the study

13 - 19

4]

Commodity markets &

20 - 27

investing in commodity
5]

markets
Trading in commodities

6]

Commodities and types of

28

29 - 63

commodities
7]

The future of commodities

Chapter 1
6

64 - 66

INTRODUCTION

Linguistically, the word commodity came into use in English in the 15th century,
derived from the French word "commodit", meaning today's (2000) "convenience" in
terms of quality of services. The Latin root meaning is commoditas, referring variously to
the appropriate measure of something; a fitting state, time or condition; a good quality;
efficaciousness or propriety; and advantage, or benefit. The German equivalent is die
Ware, i.e. wares or goods offered for sale. The French equivalent is "product de base" like
energy, goods, or industrial raw materials.

India, a commodity based economy where two-third of the one billion population
depends on agricultural commodities, surprisingly has an under developed commodity
market. Unlike the physical market, futures markets trades in commodity are largely used
as risk management (hedging) mechanism on either physical commodity itself or open
positions in commodity stock. For instance, a jeweler can hedge his inventory against
perceived short-term downturn in gold prices by going short in the future markets.
A commodity may be defined as an article, a product or material that is bought and sold.
It can be classified as every kind of movable property, except Actionable Claims, Money
& Securities. The term commodities are often used to describe commodity trading. It can
be assumed as such terms which describe the markets.
Commodity markets are markets where raw or primary products are exchanged. These
raw commodities are traded on regulation commodities exchanges in which they are
bought and sold in standardized contracts. It covers the physical products or goods (corn,
soybeans, gold, crude oil, food, etc.) markets but not the ways that services, including
those of governments, nor investment, nor debt can be seen as a commodity. It is the
relationship between simple commodity money and the more complex instruments
offered in the commodity markets. Commodities are those which we come across in our
7

daily life. Such markets are social institutions which facilitate exchange of goods for
money.

A market that transacts business with commodities of all nature referred as commodity
markets. Commodity market was initially meant only for agricultural products and that
too in the local market. Industrializations, globalizations, technological advancements,
increasing demand from consumers and intense competition from other players has paved
way for commodity markets to cross boundaries and break barriers with regards to the
commodity traded. Commodity markets deal in the trade of commodities like gold,
cotton, crude oil, orange juice etc. Many items both perishable non perishable, finished
goods, raw materials and semi finished goods will be traded in this market at the
international level. Commodity market does not necessarily require you to buy or sell the
commodities but you can even exchange them.

Commodity markets are maturing as a key investment option. Corporates with exposure
to commodities are using the commodity markets as a hedging option whereas the
investor community is diversifying their investments in equity markets with exposures to
commodity markets. Banks are trying to understand their risks in corporate credit and
trade finance portfolio with large commodity exposure. CRISIL Research aims to address
these needs through its new research solution CRISIL Commodity View.

The dynamic growths of commodities prices in recent years have put them in the center
of the scope of many investors interest. This is especially the case with oil, gold, silver
and industrial metals like copper, aluminum, zinc or nickel. The relatively high price of
raw materials has a significant impact on the condition of the global economy.
Commodities are amongst the oldest market of the world. Their beginnings date back to
ancient times, and the first organized commodities exchanges were organized in Western
Europe in XII century. The history of financial markets has been marked by the first

infamous crash of the so called tulip mania. Development and burst of the speculative
bubble in XVII century markets in Amsterdam and London was the first, but not the last
example of the interplay between greed and fear dominating the process of speculative
trading. The development of new technologies that occurred at the end of XX-century has
resulted in the dynamic growth of volumes traded on commodities markets. Commodities
and their derivatives are quoted both on Over the Counter and regulated stock exchange
markets. Brokerage house X-Trade Brokers Trading offers the possibility to trade
contracts for difference on a broad range of commodity markets. Oil, gold, silver,
platinum, copper and many more are available for real trading. Real time quotes, charts
and analysis come as standard along with the real trading platform that we provide for
our clients.

Commodity market is an important constituent of the financial markets of any country.


It is the market where a wide range of products, viz., precious metals, base metals, crude
oil, energy and soft commodities like palm oil, coffee etc. are traded. It is important to
develop a vibrant, active and liquid commodity market. This would help investors hedge
their commodity risk, take speculative positions in commodities and exploit arbitrage
opportunities in the market.

The commodity market has evolved significantly from the days when farmers hauled
bushels of wheat and corn to the local market. In the 1800s, demand for standardized
contracts for trading agricultural products led to the development of commodity futures
exchanges. Today, futures and options contracts on a huge array of agricultural products,
metals, energy products and soft commodities can be traded on exchanges around the
world.

Commodities actually offer immense potential to become a separate asset class for
market-savvy investors, arbitrageurs and speculators. Retail investors, who claim to

understand the equity markets, may find commodities an unfathomable market. But
commodities are easy to understand as far as fundamentals of demand and supply are
concerned. Retail investors should understand the risks and advantages of trading in
commodities futures before taking a leap. Historically, pricing in commodities futures has
been less volatile compared with equity and bonds, thus providing an efficient portfolio
diversification option. In fact, the size of the commodities markets in India is also quite
significant. Of the country's GDP of Rs 13, 20,730 crore (Rs 13,207.3 billion),
commodities related (and dependent) industries constitute about 58 per cent.

Chapter 2

10

Objectives
The Objectives of the study are:
1. To study the types of commodities traded in commodity market.
2. To analyse the need for investing in commodity markets.
3. To study the market characteristics of selected commodities.
4. To study the future of commodity market.

Methodology
The data has been collected secondary primary as well as primary sources:
The main is collected from the Secondary Source which is as follows:
1. Published records of mcx
2. Websites
3. Books

The primary source of information has been obtained on interacted with the
officials of mcx [multi commodity exchange]

11

LIMITATIONS

The study is restricted to only few commodities, as the data for certain commodities
was not available
The study was concentrated mainly on Indian scenario.
The majority of the data is collected from the secondary source of data.

Chapter 3

12

Need for the study

The turn of the century has brought upon a change of guard for the financial markets.
The general stock markets peaked and a new secular commodities bull was born. Even
though many have had to endure the pain of a bursting stock-market bubble, the global
economy has been thriving since the turn of the millennium and people in the future will
look back on the 21st century and tag it as the consumption age.
Globally this consumption is not necessarily that of excess or overindulgence. Rather it
may be considered more or less a movement of economic progressivism. Lending part to
this trend is the fact that our global population is growing at a blistering pace and will
continue to do so for years to come. Many people overlooked the incredible milestone
that was attained in 1999.
To put this growing and changing world into perspective, it was only about 200 years ago
that the global population passed the one billion mark. According to the U.S. Census
Bureau it only took another 118 years for the global population to double, reaching two
billion in 1922. It then took 37 years to reach three billion, 15 years to reach four billion,
13 years to reach five billion and only 12 years to reach six billion.
Today the half-way mark to the next billion has already past. Now with 6.5 billion
potential consumers living in an era in which considerable industrial and technological
advances are demanding more resources than ever, its no wonder global demand for
commodities has soared. In this high-tech world, commodities are zealously sought after
in order to maintain, support and develop this growing population. Because of this,
commodities of all types are soaring in value as their availability and economics are
continually being challenged. Simply put, supply has not been able to keep up with
demand.

13

This massively increasing population has contributed to an increase in consumption in


virtually all goods and services, and in turn has contributed to the robust economies that
are seemingly necessary in order to maintain status quo. Almost not surprising, GDP in
the U.S. has increased ten-fold since 1972, China has seen a ten-fold since 1978 and the
U.K. has seen its ten-fold since 1976. The macroeconomics here tell an incredible story
in which commodities have and will play a large part now and in the future.
It is important for everyone to understand why we are in the midst of a commodities
craze from a socioeconomic perspective, if for no other reason than to understand how it
may affect their everyday lives. It is especially important to understand this if you are an
investor. Investors and speculators who have taken part in the commodities bull thus far
have scored incredible gains if they have played the upside of this secular trend.
Its not too late though to continue to profit from this commodities bull.

To this day

commodities of all sorts are still in the midst of major economic imbalances. Global
demand for both soft and hard commodities is on the rise and supply is struggling to keep
up. It is the prudent investor or speculator who is able to recognize this pattern before it
corrects itself and is able to leverage his capital to take advantage of the upside.
Our task now is to determine which commodities to focus on from an investment
perspective. Now depending on whom you ask and where you look, the definitions for
soft and hard commodities tend to range across the board. Soft commodities tend to have
a renewing characteristic. Crops can be re-grown, and typically in the same spot as the
previous crop.

And meat commodities are the result of animal breeding that has

remarkably accurate forecasting. Softs are integral in this bull market, but are not the
major player.
Commodities such as coffee, cotton, cocoa, orange juice and hogs are examples of soft
commodities and are all non-finite in nature. As long as a global ice age doesnt

14

miraculously strike the earth, crops will always be grown. And it is doubtful that cows,
pigs and chickens will ever become extinct.
Now there are external factors that can influence the pricing of these soft commodities
and they are certainly not exempt from supply and demand pressures. Weather, disease,
geopolitical unrest and labor are examples of some of these factors. But when an
economic imbalance presents itself, the fact that these commodities are renewable
typically avoids a pushing of the panic button.
Even so, soft commodities continue to play a large role in the overall futures markets and
are not exempt from the volatility most people associate with commodities. Farmers need
to lock in prices and speculators play the game to try and capture profits. Hards consist
mainly of energy and metals and require extensive capital expenditures in order to
retrieve these commodities from the earth. These commodities are finite in nature and
have limited resources. Hards have been on a tear the last four years, have captured
mainstream media attention and are the major player in this secular commodities bull
market.
Precious metals, crude oil and natural gas are not the only commodities that have taken
part in this bull. These commodities do command the lions share of attention but lets
not overlook those others that play an integral part in the global economy. Below are
many of the popular hard commodities and their bull-to-date highs since the beginning of
2001.

- Aluminum +94%

15

- Gold +124%
- Silver +142%
- Platinum +159%
- Zinc +220%
- Lead +252
- Copper +280%
- Crude Oil +300%
- Nickel +302%
- Butane +330%
- Propane +346%
- Heating Oil +360%
- Gasoline +578% (+333% not including Katrina/Rita 3-day spike)
- Natural Gas +807% (+429% not including Katrina/Rita spike)

As it is seen, these hards have had quite a run thus far. But in addition to these above,
there are many other soft and hard commodities that trade in the futures markets. As you

16

can imagine, barring the occasional bear-market rally, commodities have been out of
favor for quite some time. Todays commodities bull is finally reflecting the importance
of commodities and the realization that in this growing global economy the resources that
support it are not to be taken for granted.

Sugar is the truly interesting story among the softs. It has performed very well in this
bull market, but for reasons that would exhibit the characteristics of a hard commodity. It
recently hit a 25-year high not because more people are putting sugar in their coffee, but
rather due to the huge increase in ethanol demand.
Sugar happens to be a common compound in ethanol production with well over 50% of
the global ethanol supply coming from it.

Ethanol consumption has significantly

increased over the years and its demand is expected to continue to rise sharply in the
years to come. As more and more countries are implementing ethanol as an alternate
energy source we are now faced with a supply-deficit in sugar.
Even with sugar as the stand-out soft commodity, it is evident that hard commodities are
the strongest of the group and have been pulling their weight, hoisting the overall index.
Hard commodities now become more of a focus and the results going forward should
reflect more on their performance. A dollar today has nowhere near the purchasing power
it did in 1981. And it is necessary to highly consider this when the true value of a
commodity is involved.
Now that weve established the fact that commodities have enormous potential even at
the nominal highs we are seeing today, how does an investor jump on board and leverage
his capital in order to profit from this? Softs are nowhere near as exciting as hards, but
regardless, softs are just plain more difficult to invest in.
Well, if you look real hard you will find various hedge funds out there that have
recognized sugars potential and have thrown capital in its direction. But ultimately for
the common investor there is really not an easy way to get a piece of the pie. Soft

17

commodities are almost exclusively traded in the futures markets. You would be hard
pressed to find a publicly traded company that produces a soft commodity and is exposed
to its price fluctuations.
Hard commodities, on the other hand, offer wonderful opportunities for investors to join
the party. Because of the massive capital expenditures and operating costs necessary to
produce hard commodities, and because funding is always a challenge, most producers
and servicers of these sorts are publicly traded in the stock markets. Its custodians goal is
to reflect the commodities that are most important and influential in todays economy.
Energy and metals are such commodities today and are currently faced with serious
economic and fundamental challenges.
Demand for these resources has reached unprecedented territory in order to service
todays global economy. And the supply that is being mined and drilled is not only slow
to meet this demand, but for many of these commodities the reserves for future supply are
quickly dwindling with new discoveries becoming increasingly difficult to find.
The reason you see these immense gains in hard commodities is because of the now and
future economic imbalances that present themselves. For many years capital has poured
into the general stock markets with focus on tech stocks, and though commodities need
significant funding in order to sustain future supply, the funds had just not made it their
way. For many years exploration budgets were slashed and new discoveries were few
and far between.

This brazen ignorance of commodities for so long has finally

commanded the worlds attention.


Its going to take many years for commodities producers to ramp up output in order to
meet this increasing demand and even more to renew and build reserves for future
sustainability. Because of this prices will most likely continue to rise as much-needed
capital is directed towards these commodities producers.

18

Now, the wonderful thing about these hard commodities producers is that most are
publicly traded companies. Investors and speculators indeed have the opportunity to
leverage their capital at the epicenter of this global commodities shortage.
Some commodities producers are more leveraged than others to their underlying product,
but ultimately the stocks of these producers can be looked at as non-expiring call options
in their various sectors that should continue to soar as this secular bull market in
commodities climbs.
The stocks for many of these companies have produced gains far better than those of their
underlying commodities thus far. And as the prices of their products rise as we expect
them to, if they are leveraged correctly so will their profits rise.

The continued

appreciation of their stock price will reflect such.


So as an investor or speculator looking to invest in these stocks, which ones do you
choose? There are literally hundreds upon hundreds of stocks that fall into this category.
As the short-term cycles within a long-term trend flow and ebb with upward momentum,
it will be profitable to invest and speculate in metals and energy-related stocks.
The bottom line is commodities are still in the early part of a secular bull market. The
global economy is starved for commodities and producers are struggling to keep up with
demand. It will take many years for todays economic imbalances to correct themselves
and prices should only continue to rise.
The best way for investors and speculators to leverage their capital in order to take
advantage of this commodities bull market is to invest in the stocks of the companies that
produce these commodities.

Chapter 4
Commodity Markets - To or Not to Invest?
19

A market that transacts business with commodities of all nature referred as commodity
markets. Commodity market was initially meant only for agricultural products and that
too in the local market. Industrializations, globalizations, technological advancements,
increasing demand from consumers and intense competition from other players has paved
way for commodity markets to cross boundaries and break barriers with regards to the
commodity traded.
Commodity markets deal in the trade of commodities like gold, cotton, crude oil, orange
juice etc. Many items both perishable non perishable, finished goods, raw materials and
semi finished goods will be traded in this market at the international level. Commodity
market does not necessarily require you to buy or sell the commodities but you can even
exchange them.
Commodity market works on certain principles. Firstly the trading has to be done only
for standard products. Secondly the transaction takes place through a future contract.
According to this contract the commodities will be sold or bought on a future date.
However the price at which they are sold will be the price agreed during the contract.
Similarly commodity marketing also makes use of another type of contract called spot
contract. In this contract the goods are to be transferred as soon as the contract is made.
However it has also been argued that the purpose of a spot contract is to exercise a future
contact in due course of time. Some of the commodities investing market are commodity
food market, commodity petroleum market and commodity fund investing.

Investing in Commodities

20

Commodity investing was initially received well only by a few sectors. Commodities
investing were first restricted to the trade and exchange of commodities meant for regular
and day to day use. However the awareness in the subsequent stages has brought all
sectors into the manifold of commodity investing and has enabled speedy movements,
transfer and transaction of goods and services.

Reduced Risks
As an investor your chances of risks are very less if you choose to invest in commodity.
Therefore the gains from commodity investing will be helpful for you to balance other
losses due to other financial instruments in your portfolio. The chances of risks are lower
because commodity investing primarily deals with diverse items. Moreover when the
contracts are entered for a future date at the current time you can exercise reasonable care
and see to it that the chances of risks are reduced or nil

Helps to Fix Price Easily


The performance of commodity market can be monitored by analyzing the performance
of bond and share market because in most cases a commodity market will perform well
when the others don't perform and vice versa. It is therefore possible to easily predict the
prices and make the contracts by considering the ups and downs in other markets. A
prerequisite for this is that the assets in the commodity market should not be correlated
with the stock and bond market.

Why do retail investors lose in commodity markets?

21

There has been a strong buzz in the market that retail investors lose more than they gain
in the commodity market. In most cases, it is more important to know HOW one is
investing than WHO is investing.
Reports indicate weak retail investment in UK commodity markets but more interest
shown in Germany, Asia.
Small retailers and investors usually are looking for an avenue to diversify their portfolio,
to invest their hard earned money to get decent returns. Studies indicate that commodities
are an effective portfolio diversifier and have been around for some time now. It has
taken the recent economic climate for commodities and not just a cyclical opportunistic
market to be regarded as a genuine asset class.
Small investors do have an opportunity to make money in the commodity market, but you
need to work equally hard to multiply your money. Finding a good broking house is
important, but even more important is understanding the trade, researching on your own
and taking responsibility of your money.
It is always considered better to start with a couple of commodities you like or
understand better. More preferred commodities can be ones information on which are
easily and widely available. Trading on tips and judgment of others would not assure
gains for a longer time.
Sort for an accurate information medium, be it a newswire, a website, periodical or an
expert. Make a combination and use your judgment. Understand your risk taking
potential and play with stop losses.
Trading in commodities can provide you with kind of returns that you may not find in
markets due to high leverage advantage. And there are other instruments also opening for
retail participants, latest being ETFs.

22

There are some lags in the system though. The Indian markets are yet to come out of
clutches of the big groups, who tend to manipulate the markets. Scarcity of experienced
professionals who understand the nitty gritty of the market is widely felt. The challenge
has grown even tougher with several new firms launching commodity desks and
expanding operations. Given these factors there always is a risk that individual investors
or retail participants may be putting in their hard earned money without sufficient
understanding of the associated.

Why Invest in Commodities? Diversification and Inflation


Protection
Investor interest in commodities has soared in recent years as the asset class has
outperformed traditional assets such as stocks and bonds. The performance of
commodities as an asset class is usually measured by the returns on a commodity index,
such as the Dow Jones-AIG Commodity Index, which tracks the return from a passive
investment in 19 different commodity futures contracts. Over the five-year period ended
March 31, 2006, the Dow Jones AIG Commodity Index has returned 10.6%, versus 2.6%
for the S&P 500.
Commodity prices have been driven higher by a number of factors, including increased
demand from China, India and other emerging countries that need oil, steel and other
commodities to support manufacturing and infrastructure development. The commodity
supply chain has also suffered from a lack of investment, creating bottlenecks and adding
an insurance premium and/or a convenience yield to the returns of many commodity
futures. Over the long term, these economic factors are likely to support continued gains
in commodity index returns.

23

The potential for attractive returns is perhaps the most obvious reason for increased
investor interest in commodities, but not the only factor. Commodities may offer
investors other significant benefits, including enhanced portfolio diversification and a
hedge against inflation and event risk.
Commodities are real assets, unlike stocks and bonds, which are financial assets.
Commodities, therefore, tend to react to changing economic fundamentals in ways that
are different from traditional financial assets. For example, commodities are one of the
few asset classes that tend to benefit from rising inflation. As demand for goods and
services increases, the price of those goods and services usually rises as well, as do the
prices of the commodities used to produce those goods and services. Because commodity
prices usually rise when inflation is accelerating, investing in commodities may provide
portfolios with a hedge against inflation.

Q. Dont you think stock market is simpler than commodity


market? So why should an investor invest in commodities
market?
This question is very valid. Do you know in 1992-93 if you had gone to marry daughter
of a stock broker, your father would have been horrified. After 15 years, people dont find
stock market as a bad profession. In fact, most people go to broking companies as
research analysts and it is a very reputed job. Now that mindset is there in commodities.
Today, maybe after 10 years why people were against commodity broking? Its a matter
of time that things will change.

Commodity Investment Strategies

24

Capturing the full benefits of commodity exposure has been a challenge in the past.
Investing in physical commoditiesa barrel of oil, a herd of cattle or a bushel of wheat
is impractical, so investors have tended to seek commodity exposure either by purchasing
commodity-related equities or through actively managed futures accounts.
However, these investment strategies may not capture the potential diversification and
other benefits of commodity exposure in a portfolio. For example, commodity-related
equities will not necessarily reflect changes in the price of commodities.
If an oil producer has already sold its supply on a forward basis, the producers stock
price may not fully benefit from a rise in the price of oil. Commodity-related equity
returns can also be affected by the issuers financial structure or the performance of
unrelated businesses. In fact, commodity-related equities may actually have a higher
correlation to movement in equities than the commodity market. Actively managed
commodity futures accounts also may not provide the benefits of commodity exposure
suggested by historical commodity index performance, because these accounts tend to
reflect the managers skills at selecting the right commodities, at the right time, rather
than the inherent returns of the commodity market.

The emergence of investment vehicles that track commodity futures indices has provided
investors with another option for gaining exposure to commodities that may offer better
potential to capture the full benefits of the asset class. Investment vehicles that track
commodity futures indices are not the same as actively managed futures accounts.
Instead, commodity index returns provide passive exposure to a broad range of
commodities. For example, the Dow Jones AIG Commodity Index tracks the futures price
of 19 different commodities, including energy, livestock, grains, industrial metals,
precious metals and soft commodities. Changes to the composition of the index are
determined by preset rules rather than a managers discretion.

25

Dow Jones-AIG Commodity Index Components

As of March 31, 2006


Source: AIG
One advantage of commodity exposure that tracks a broad index is that commodities are
not highly correlated with each other and index returns should be less volatile than the
returns on an individual commodity. Another advantage is that commodity indexes
themselves have existed for decades, providing ample historic data for asset allocation
studies and research.
While broad commodity exposure can provide investors with a number of potential
benefits, investing in commodities entails risks as well. In particular, commodities may
not perform well during cyclical downturns in the U.S. or global economy, when
consumer and industrial demand slows. Commodities have historically been about as
volatile as the equity market. For example, from December 1990 through March 2006,
annualized monthly volatility for the Dow Jones-AIG Commodity Index was 12.2%
compared to 13.8% for the S&P 500. More recently, from June 2001 through June 2006,
26

annualized monthly volatility for the Dow Jones-AIG Commodity Index was 13.9%,
slightly above the 13.5% volatility of the S&P 500 over the same period. Commodities
are a distinct asset class with returns that are largely independent of stock and bond
returns. Therefore, adding broad commodity exposure can help diversify a portfolio of
stocks and bonds, lowering risk and potentially boosting return. Achieving this
diversification has been made easier with the development of investment products that
passively track a broad range of commodities.

Chapter 5

27

Why Trade In Commodities?


Although commodity derivatives command a humble share of 6% in the derivatives
segment across the world, yet these record high volumes in the markets the world over
compared to equity derivatives. In an era where risks to investments are on the rise, India
needs to switch to commodity derivatives and also to weather derivatives (when these are
launched), if it needs to top the list of developed nations.
Of course with the other asset classes offering attractive returns, "Why Commodities?" is
the inevitable question that pops in one's mind today, more so considering that the BSE
Sensitive Index is scaling new highs by the day. Well, despite offering relatively lower
returns, commodity derivatives provide unique money-making opportunities to a wider
section of market participants, starting from planters to exporters, importers at all. And to
the agrarian Indian population commodities are obviously not new, nor are the
advantages of trading in them unknown. No balance sheet, P&L statement, EBITDA and
reading between the lines. Commodity trading is about the simple economics of supply
and demand. Supports are known, only resistance matters! Minimum support price acts as
a statutory support for many commodities. No Dollar-Rupee premiums/discounts. No
hedging on the NYMEX. Indian commodity derivatives hedge both forex and commodity
specific risks at a single cost. No breaking of heads over market direction. Seasonality
patterns quiet often provide clue to both short- and long-term players. No scam, no price
rigging. Commodity trading comes with nil insider trading and company specific risk.
What's more, why invite risk by investing in a metal company when you can trade in the
metal itself? After all, while the stock price of the company is dependent on several
factors including the company's own fundamentals, the price of the metal is driven by the
simple economics of demand and supply. The more the demand for the metal, the higher
its price and vice versa. Also compared to equities it is much cheaper to trade in
commodities, where margin requirements are lower.

Chapter 6

28

Different types of commodities

A} METALS

Different types of metals are as follows:

1} GOLD:

Introduction:
Gold is primarily a monetary asset and partly a commodity.
More than two third of golds total accumulated holdings, relating to value for
investment, is with central banks reserves, private players, and high-karat
jewelry.
Less than one third of golds total accumulated holdings is a commodity for
jewelry in western markets and usage in industry.
The Gold market is highly liquid and gold held by central banks, other major
institutions and retail Jewellery keep coming back to the market.
Due to large stocks of Gold as against its demand, it is argued that the core driver
of the real price of gold is stock equilibrium rather than flow equilibrium.

29

Economic forces that determine the price of gold are different from, and in many
cases opposed to the forces that influence most financial assets.
South Africa is the world's largest gold producer with 394 tons in 2001, followed
by US and Australia.
India is the world's largest gold consumer with an annual demand of 800 tons.

Market Characteristics:
The gold market is highly liquid. Gold held by central banks, other major
institutions, and retail jewelry is reinvested in the market.
Due to large stock of gold, against its demand, it is argued that the core driver of the
real price of gold is stock equilibrium rather than flow equilibrium.
Effective portfolio diversifier: this phrase summarizes the usefulness of gold in
terms of Modern Portfolio Theory, a strategy which is utilized by many
investment managers today. Using this approach, gold can be used as a portfolio
diversifier to improve investment performance.
Effective diversification during stress periods: Traditional methods of portfolio
diversification often fail when they are most needed, that is during financial stress
(instability). On these occasions, the correlations and volatilities of return for most
asset classes (including traditional diversifications, such as bonds and alternative
assets) increase, thus reducing the intended cushioning effect of a diversified
portfolio.

Demand and supply:

30

South Africa is the worlds largest gold producer with 297 tonnes in 2005,
followed by the US and Australia.

India is the worlds largest gold consumer with an annual demand of 800 toones.

Demand and supply of gold:


Supply

in tonnes
2005

2006

Change%

Mine production

658

635

-3

Net producer

-14

62

hedging
Total mine supply

644

573

-11

Official sector sales

85

59

-31

Old gold scrap

211

192

-9

Total supply

940

824

-12

Demand

31

Fabrication

Jewelry

659

664

Industrial & dental

108

114

Sub total of above

768

778

Bar & coin retail

93

100

investment
Other retail

-8

-8

investment
ETFs & similar

38

19

-49

Total demand

890

889

Balance

50

-65

fabrication

Factors influencing the market:

Above ground supply from sales by central banks, reclaimed scrap, and official
gold loans.

Producer/ miner hedging interest.

World macroeconomics factors such as the US dollar and interest rate.

Comparative returns on stock markets.

Domestic demand based on monsoon and agriculture output.

2} SILVER:
32

Introduction:
Silver has unique properties such as its strength malleability, ductility, electrical and
thermal conductivity, sensitivity, high reflectance of light, and reactivity.
There are few substitute metals for silver in most application, particularly in high-tech
uses in which reliability, precision, and safety are paramount.
Today, silver is sought as a valuable and practical industrial commodity and as an
appealing investment.
The largest industrial users of silver are the photographic, jewelry, and electronic
industries.
Newly-mined metal provides most of the needed supply.
Mexico, United States, and Peru are the primary producers.
Secondary silver sources include coin melt, scrap recovery, and dis-hoarding from
countries where export is restricted. Secondary sources are price sensitive.

Demand for silver is based on three main factors: industrial and decorative uses,
photography, and jewelry and silverware. These three categories together have more than
95% of annual silver consumption. In 2005, 409.3 million ounces of silver was consumed
for industrial applications, over 164.8 million ounces I the photographic sector, and 249.6
million ounces in the jewelry and silverware markets.

Indian Scenario:
33

Silver imports into India for the domestic consumption fell sharply by 25% to
about 3400 tonnes in 2005, against the record year 2001 when over 4540 tonnes
of silver was imported.

Indian industrial demand was estimated to about 1680 tonnes for the year 2005.
India is one of the largest users of silver in the world, ranking alongside industrial
giants like Japan and United States.

GFMS data shows Indian jewelry and silverware fabrication was around 1520
tonnes in 2005.

World markets:

Silver is predominantly traded on the London Bullion Association (LBNA) and


COMEX in New York. LBNA is the global hub of over-the-counter (OTC)
trading in silver and is the main physical market. Comex is the futures and
options exchange, where most fund activity is focused.

Silver is invariably quoted in US dollars per troy ounce.

34

Demand and supply:


After seeing a solid growth in 2005, total fabrication demand slightly dipped by
around 3% in 2006.
Industrial demand marginally increased year-on-year in 2006.
Photographic demand continuously dipped due to impact of digital technology.
Import of silver into collapsed in 2006 due to impact of high prices, stocks carried
over from 2005, and the government selling silver in local markets.
Coins demand has increased in 2006.
Investment demand has grown again.

Demand of silver in 2006:

35

Coins

5%

Investment

9%

Photography

16%

Jewellary&

24%

silverware
Industrial

46%

Supply of silver in 2006:


Hedging
Government

1%
8%

sales
Scrap silver
Mine

21%
70%

3} COPPER:
Introduction:

production
Copper is a metal that has the desirable
physical properties of being malleable (it can
be hammered and molded into shapes) and
ductile (it can be drawn into wire). As a result,
copper pipes are used to bring water to and
from our buildings.
Copper is a good conductor of electricity; million of miles of copper wire crisscross
the landscape and run through our buildings.

36

Copper alloys (such as brass) are important components in many household products
and machines.
It is believed that the amount of copper a society consumers is a direct indicator of the
advancement of that society.

Demand and supply:


Copper is not a rare metal; it is produced in many countries. Today, copper supply arises
from two sources; its majority (88%) comes from primary production-new copper that is
mined from the ground. But the most important is its secondary supply, which accounts
for 12% of total refined copper supply. The secondary supply comes from recycling of
the copper scrap.
Between 1900 and 2000, copper demand grew from02 million tonnes to around 13
million tonnes with an accelerating growth since the 1950s. With many widespread uses,
copper demand is growing. Now with China, India, and many other developing countries
starting to industrialize and urbanize, copper demand is likely to grow extensively. The
per capita demand for copper rises in line with GDP. Japan consumers around 12 kg of
copper per capita, north America around 10 kg per capita, and Europe around 9 kg per
capita. The large populations of China, India, Eastern Europe, and South America are all
consuming less than 2 kg per capita. This is a clear indicator of the future copper demand.

Indian scenario:
Major producers of refined copper: Hindalco, stertile industries, and &
Hindustan copper.
37

Indian copper market: roughly 3% of the global market.


Indian production of refined copper: 650000 MT annually.
Indian demand for refined for refined copper: 450000 MT annually.
India is emerging as a net exporter of refined copper.
Over 90% of the concentrate requirement is imported.

Factors influencing the market:


There are numerous factors that can influence production-consumption of copper and so
its prices. In North America and South America, copper production is often affected by
labor unrest; in parts of Asia and Africa, the production can be affected by political
unrest; additional influences can be from weather, floods, and droughts either hitting the
production process or the transport of raw materials. New production also takes years to
commission as the scale of mining is large, it takes enormous financing and requires
endless environmental permissions and needs extensive infrastructure as well. All these
factors make it hard for the market to balance the supply and demand.
Copper prices change constantly as the market attempts to balance the supply and
demand at any given time. Price fluctuations generate risk and opportunity to different
38

participants in the market, and the metal exchanges around the world provide the means
for all those involved with the market to either hedge their risk or take risk as an investor
or speculator.

4} ZINC:
Introduction:
Zinc is the fourth most widely used metal after steel, aluminium, and copper.
Zinc also exists in many compounds.
Due to its resistance to non-acidic atmosphere corrosion, zinc is instrumental in
extending the life of buildings, vehicles, ships, and steel goods, structures of every
kind.
Zinc is a bluish white lustrous metal. It is normally covered with a white coating
on exposure to the atmosphere.
39

Zinc dust is flammable when exposed to heat and burns with a bluish green flame.

Zinc plays a very significant role in normal human growth, but exposure to high
levels of zinc through inhalation,
Ingestion and dermal contact can cause adverse health effects.

Galvanized steel is used extensively in construction, engineering, and auto industry to


increase the corrosion resistance of cars, trucks, and trailers.
The engineering industry also uses zinc pressure die casting to produce thousands of
components for cars, household items, and industry in general. These range from
carburetors, casing, water pumps, moldings, the side and back panels of washing
machine, cooker, etc. Zinc sheet is used in some countries for roofing, guttering, and
general weather-proofing.

Demand:
The growth of Zinc demand in the western world is relatively quiet, and downturn in
construction and auto industries is likely to depress the western demand further.
However, Asia, and especially China, has seen a remarkable increase in Zinc demand.
And with an increasing infrastructure development in china, Zinc demand is likely to
grow strongly for many years to come.

Supply:

40

Zinc production stars with the mining of bulk ores, which often contain a mixture of lead
zinc, and silver. Zinc concentrates are electrolytically smelted to produce high grade
and special high grade zinc, with purities of 99.95%and 99.99% respectively. The
latter-quality zinc is the benchmark grade for LME contracts. Zinc is produced
extensively in North America, South America, Asia, Australia, and Europe.

Indian Scenario:
The Indian zinc industry entered its transformation phase with the privatization of the
largest zinc producer, Hindustan Zinc Ltd. The domestic zinc industry is now completely
under private sectors and is in the midst of an extensive expansion program. The size of
the Indian zinc market is 4.5 lakh tones per annum.

By 2020, India is expected to attain a complete self sufficiency in meeting its zinc
demand. Thereafter, the process of India becoming an important zinc supplier to the
world would be initiated, provided that another phase of capacity expansion is effected.
Hindustan Zinc Ltd. Is the largest zin producer in India with a capacity of 4 lakh tones
per annum. Binani Zinc is the other major player with a capacity of 38000 tonnes per
annum. Over the next five or six years, zinc demand is likely to grow at 12-15 percent
annually, against the global average of 5 %. Even if one assumes that the zinc demand
grows by 10% till 2010 and at slower 7%, India would require zinc capacity of 14 lakh
tpa by 2020 in order to be self reliant. The next round of large capacity addition would,
therefore, be warranted from 2008 onward. Buoyancy in the domestic zinc demand
primarily emanates from the boom in the steel industry, given that over 70% of zinc is
used for galvanizing.

41

Factors influencing the market:


Changes in inventory level at LME warehouses
Economic growth rate of major consuming countries
Global growth and demand in major consuming industries
Prices of the alternative metal(s)
Participation of funds

5} ALUMINIUM:
Introduction:
Aluminium is the third most abundant element found in the earths crust. It exists
in very stable combinations with other materials particularly and oxides.
Aluminium is lightweight and weights only one third as compared to copper;
while its density is only one third that of steel.
It is resistant to common atmosphere gases and a wide range of liquids. Hence,
aluminium is known for its durability and high resale value.
It has high reflectivity and therefore has more decorative uses.

42

Besides a good conductor of heat and electricity, aluminium also keeps its
toughness down to very low temperature without becoming brittle like carbon
steels. So, it is easily worked and molded.

Applications:
Aluminium is widely used in the construction, transportation, and packaging industries.
Its attributes are ideal for the construction business. The metal is strong, light, corrosion
resistant, and versatile. It is used in constructing windows, doors, cladding, weatherproofing, and in light constructions such as conservatories and canopies. In the
transportation industry, aluminium is used in the auto, aerospace, railways, and marine
industries. Its strength, light, and resistance to corrosion are ideally suited for the
construction of the shell and bodies as well as in working parts, fixtures, fittings, and
engine components. In air craft, aluminium and aluminium alloys account for around
80% of unladen weight. In auto production, aluminium is gaining market share from
steel.
In packaging industry, aluminium is used extensively for the protection, storage, and
preparation of food and drinks. It can also be easily recycled, which makes it an
environment-friendly packaging material. Aluminium is used in overhead and
underground power lines and power cables.

Demand and supply:


Aluminium is the largest base metal consumed annually. It benefits the rapid
industrialization and urbanization of developing countries like china and India. The
aluminium demand is set to accelerate sharply. The primary aluminium demand has risen

43

from 2 million in 1950 to 9.5 million tones in 1970, and then 15 million tonnes in 1990,
which is expected to rise to 35 million tonnes in 2007.
There are three stages of production of primary aluminium. It starts with the mining of
bauxite, a reddish brown aluminous earth found in tropical latitudes in Australia, South
America, India, the Caribbean, and Africa. Bauxite is then refined to produce alumina,
which is then smelted to produce aluminium. To produce one tonne of primary
aluminium, we need two tonnes of alumina, which in turn takes about four tonnes of
bauxite. The reduction of aluminium from its oxide, alumina is very power-intensive,
which is why the significant world primary aluminium production is located near cheap
energy sources, whether it be hydroelectric power in Canada or oil and gas fields in
middle east. It is important to understand the huge energy requirement to produce
primary aluminium. The Hillside smelter in South Africa produces around 460000 tpy of
aluminium, but to do so it consumes about 5% of all electricity consumed in South
Africa.

Global Scenario:
Aluminium ores (most commonly, bauxite) are in abundance and found mainly in tropical
and subtropical areas of Africa, West Indies, South America, and Australia. Some deposits
are also found in Europe. The leading aluminium producing countries include the United
States of America, Russia, Canada, the European Union, China, Australia, Brazil,
Norway, South Africa, Venezuela, the Gulf countries (Bahrain and the United Arab
Emirates), India, and New Zealand. These countries together represent more than 90% of
the global primary aluminium production.

Indian Scenario:
India is the fifth largest producer of aluminium in the world. India produces
approximately 3037 million tonnes of all categories of bauxite.
44

At current levels of consumption, the existing reserves will have an estimated life of over
350 years. Indias reserves are estimated to be 705% of the global deposits, and the
installed capacity is about 3% globally. In terms of demand and supply, India is self
sufficient and has a competitive export potential. Indias annual export of aluminium is
about 82000 tonnes. Indias annual consumption of aluminium is around 0.61 million
tonnes and is projected to increase to 0.78 million tonnes during 2007. The primary
Indian aluminium producers include NALCO, HINDALCO, and Vedanta Group.
Aluminium prices in India are fixed on the basis of the prices prevailing on LME.

Factors Influencing the Market:


The production of aluminium requires alumina and uninterrupted supply of electricity.
However, in recent years there have been a host of issues, which have affected aluminium
supply; most important of these is electricity. In 2001, energy shortages in US resulted in
electricity prices spiraling higher to the extent that it was more profitable for some
aluminium smelters to stop producing aluminium and to sell their electricity quotes to
other users. So at peak energy usage times, such as during the summer when air
conditioning consumes huge amounts of energy, aluminium smelters have to cut
production to release electricity for other users.
The following are some other factors that can influence the aluminium market:
Changes in inventory stocks at LME, SHFE, COMEX, and TOCOM warehouses
World aluminium mine production through exploration of new mines and
expansion of existing mines
Economic growth of major consuming nations such as China, Japan, Germany,
etc.

45

Growth and demand in the construction, packaging, and transportation industry.

6} NICKEL:
Introduction:
o Nickel is the main alloying metal used in producing certain types of stainless
steel.
o The strength and durability of products built with stainless steel is vastly superior
to similar products built with non stainless steel.

Applications:

46

Among base metals, nickel is the most volatile owing to its strong demand and light
supply. Nickel demand is derived based on the growth of different industrial sectors and
thus exhibits high volatility. Nickels primary use (65%) is in the manufacturing of
stainless steel, 20% in other steel and nonferrous alloys, 9% in electroplating, and about
6% used in coins and nickel chemicals. Demand foe stainless steel took off in the mid1980, especially in the chemical engineering, paper and food processing industries, where
stainless steels high melting point, high resistance to corrosion and oxidation, and
strength, made It invaluable as it could withstand the heat, chemical, acid, and pressure
that these industrial processes require. Stainless steel is also used in construction and
household items such as kitchen sinks, pots, pans, utensils, and work surfaces. Nickel is
also used to produce super-alloys which are used extensively in the aerospace industries.
Mobile phones, computers, digital cameras, etc., all need small, lightweight, highcapacity power sources. Nickel cadmium and other nickel alloys have been used to
produce some of these batteries

Demand and supply:


Nickel, or more to the point stainless steel, Is a relatively new metal; its use has grown
significantly as Asia and China have built up their infrastructure. Growth in nickel
demand is expected to come primarily from further growth in stainless steel. In recent
times, high nickel prices resulted in rise in the number of stainless steel producers
switching from producing high nickel based stainless steel (austenitic stainless steels or
300 series) to low nickel based stainless steel (200 series).World nickel market is
characterized by rising demand and constrained supply. More than 54% of the worlds
total supply comes from only five companies. Global nickel consumption is growing at a
rate of 3.1% a year. Nickel occurs as oxides, sulphides, and silicates. Nickel ores are
mined in about 20 countries and smelters (or refined) in about 25 countries. Primary
nickel is produced and used in the form of Ferro-nickel, nickel oxides, and other
chemicals as more or less pure nickel metal. Nickel is also readily recycled in many of its

47

applications. A large amount of secondary or scrap nickel is used to supplement newly


mined metal.
For a long time, about 1.4 MT nickel production has been in the hands of a few large
producers; the largest producers base is in Russia. The combination of a small producer
base and the lack of transparency show that the nickel supply has at times been volatile. A
strike at a producer can quickly tighten its supply. Likewise, unclear and secretive
production and shipping production and shipping schedules, combined with ever
changing export and tax legislation in Russia, can have a big impact on the market
sentiment. Although nickel is concentrated in the hands of a few producers, its
geographical production base is quite evenly spread. About 29% nickel is produced in the
former eastern bloc, 21% in the Americas, 16% in Europe, 15% in Australia, 14% in Asia,
and 5% in Africa. The aggregate worldwide production is estimated to be 1.30 MT.

Indian Scenario:
Nickel market in India is totally dependent on import. India imports around 30000 tonnes
of nickel. With a growth in the stainless steel sector, the nickel import demand is
expected to increase in the coming years. Steel scrap has emerged as a good substitute for
the primary metal.

Factors Influencing the Market:


Above ground supply from scrap
New mines discovery

48

Nickel demand is a derived demand thus is the situation in various industries


Growth in consumption of stainless steel.

7} LEAD:
Introduction:
Lead is a very corrosion-resistant, dense, ductile, and malleable blue-gray metal that has
been used for at least 5,000 years. Early uses of lead included building materials,
pigments for glazing ceramics, and pipes for transporting water. Today's major use of lead
is in lead-acid storage batteries. The electrical systems of vehicles, ships, and aircraft
depend on such batteries for startup, and, in some cases, batteries provide the actual
motive power. It is also for soundproofing in office buildings, schools, and hotels. It is
widely used in hospitals to block X-ray and gamma radiation and is employed to shield
against nuclear radiation both in permanent installations and when nuclear material is
being transported. .

49

Supply & Demand Scenario:

Domestic Scenario

Lead production equalled approximately 82,000 tonnes in 2004, mostly from


secondary sources.

The main constraint in lead production in the country is the lack of lead ore
reserves, which necessitates large-scale imports and recycling.

Lead demand in India was estimated at 150,000 tonnes for 2004. Due to huge gap
in demand-supply, India imported nearly about 50% of its domestic demand.

The major suppliers for the imports were China, the Republic of Korea and
Australia: 54%, 15% and 10% respectively.

The domestic industry is characterized by the presence of only a few players in


the primary segment. The primary lead industry in India is divided between the
following main players: Binani Industries Limited and Sterlite Industries (India)
Ltd. (Hindustan Zinc Ltd.). Due to increasing use of lead in domestic market both
players are expanding their smelting capacities for lead.

World Scenario:
o USA, Japan, China, EU and India are the major consumers of Lead

50

o Supply is controlled by Australia and China.


o Lead in the global market is traded as soft lead, animated lead, lead alloys and
copper-base scrap.

Factor influencing demand and supply:


o Changes in inventory level at LME warehouses
o Economic growth rate of major consuming countries
o

Global growth and demand in major consuming industries

o Prices of the alternative metal(s)


o Participation of funds

B} ENERGY:
1} BRENT CRUDE OIL:
Introduction:
Brent crude oil is a light sweet crude oil from North Sea.
It has API (American Petroleum Institute) gravity between 38-39 and has higher
sulphur content than the other well-known benchmark, WTI crude oil.
Brent crude oil is a global benchmark for other grades and is widely used to
determine crude oil prices in Europe and in other parts of the world.
Brent is typically refined in Northwest Europe, but a major portion is been exported
to the US Gulf and East Coasts, and also to parts of Mediterranean.
51

It is more expensive than the Organization of Petroleum Exporting Countries (OPEC)


basket, but lesser than West Texas Intermediate (WTI) because of higher sulphur
content than the WTI crude.
Crude Oil Units (average gravity)
1 US barrel = 42 US gallons.
1 US barrel = 158.98 litres.
1 tonne = 7.33 barrels.
1 short ton = 6.65 barrels.
Note: barrels per tonne vary from origin to origin.

Global Scenario
Oil accounts for 40 per cent of the world's total energy demand.
The world consumes about 76 million bbl/day of oil.
United States (20 million bbl/d), followed by China (5.6 million bbl/d) and Japan
(5.4 million bbl/d) are the top oil consuming countries.
Balance recoverable reserve was estimated at about 142.7 billion tons (in 2002),
of which OPEC was 112 billion tons.

Indian Scenario:
India ranks among the top 10 largest oil-consuming countries.
Oil accounts for about 30 per cent of India's total energy consumption. The
country's total oil consumption is about 2.2 million barrels per day. India imports
about 70 per cent of its total oil consumption and it makes no exports.
India faces a large supply deficit, as domestic oil production is unlikely to keep
pace with demand. India's rough production was only 0.8 million barrels per day.

52

The oil reserves of the country (about 5.4 billion barrels) are located primarily in
Mumbai High, Upper Assam, Cambay, Krishna-Godavari and Cauvery basins.
Balance recoverable reserve was about 733 million tons (in 2003) of which
offshore was 394 million tones and on shore was 339 million tons.
India had a total of 2.1 million barrels per day in refining capacity.
Government has permitted foreign participation in oil exploration, an activity
restricted earlier to state owned entities.

2} NATURAL GAS:
Introduction:

Natural gas is a colorless, odorless, environment-friendly energy source, which is


cleanest of all the fuels that are traditionally being used in India.

Natural gas is a highly flammable hydrocarbon gas chiefly consisting of methane


(CH4). It may also include other gases such as oxygen, hydrogen, nitrogen,
ethane, ethylene, propane, and even some helium.

In Indias energy mix, natural gas is fastest growing energy source. Its
consumption in India is expected to grow by 10% during 2005-2010. This can be
met by liquefied natural gas (LNG) imports as well as domestic gas discoveries.

53

Natural gas is used mainly in industrial, commercial, transportation, and domestic


sectors. The power and fertilizers sectors are the largest consumers of naturals
gas.

Natural gas, converted into a liquid state by cooling it to -161c, is termed as


LNG. LNG is more compact than natural gas and occupies 1/600 th of its gaseous
volume.

Natural gas, when compressed at a pressure of 250 bars, is termed as compressed


natural gas (CNG).

Applications:

Electricity

generation

by

utilities:

fuel

for

base

power

plants

and

cycle/cogeneration power plants.

Public and commercial: A natural gas is a clean fuel for use in household use of
piped natural gas (PNG) is expected to increase in future.

Industrial: Natural gas s used as a fuel for all the utilities like boilers, furnaces,
banking ovens, air conditioning, etc.It is also used as a feedstock by fertilizer
companies.

Alternative motor fuel: Used in compressed (or CNG) form.

Petrochemicals: A variety of chemical products (for example, methanol) can be


derived from natural gas.

Demand and supply:


Natural gas supply is expected to increase by 143% over the next five years,
because many gas discoveries are starting their production and various LNG
projects are being commissioned or expanded.
54

Transactional gas being planned and pursued with great vigor by companies like
GAIL, Reliance, etc. This will result in a better flow of gas to the deficit regions
in the country.
As per India Hydrocarbon Vision 2025, the natural gas demand is expected to be
313 million standard cubic meter per day (MMSCMD) by 2011-2012.
New sources of gaseous fuel, like coal bed methane, underground coal
gasification, etc., will be opened up.
The latent demand of gas is estimated to be twice its supply.

Factors influencing the market:


OPEC output and supply.
Geopolitics.
Dollar fluctuations.
US natural gas inventory data.
Weather conditions.
3} CRUDE OILS:

Introduction:

Crude oil is a mixture of hydrocarbons that exists in a liquid phase in natural


underground reservoirs. Oil and gas account for about 60 per cent of the total
world's primary energy consumption.

Almost all industries including agriculture are dependent on oil in one way or
other. Oil & lubricants, transportation, petrochemicals, pesticides and insecticides,
paints, perfumes, etc. are largely and directly affected by the oil prices.

Aviation gasoline, motor gasoline, naphtha, kerosene, jet fuel, distillate fuel oil,
residual fuel oil, liquefied petroleum gas, lubricants, paraffin wax, petroleum
coke, asphalt and other products are obtained from the processing of crude and
other hydrocarbon compounds.
55

The prices of crude are highly volatile. High oil prices lead to inflation that in turn
increases input costs; reduces non-oil demand and lower investment in net oil
importing countries.

Crude Oil Units (average gravity)


1 US barrel = 42 US gallons.
1 US barrel = 158.98 litres.
1 tonne = 7.33 barrels.
1 short ton = 6.65 barrels.
Note: barrels per tonne vary from origin to origin.

Global Scenario:
Oil accounts for 40 per cent of the world's total energy demand.
The world consumes about 76 million bbl/day of oil.
United States (20 million bbl/d), followed by China (5.6 million bbl/d) and Japan
(5.4 million bbl/d) are the top oil consuming countries.
Balance recoverable reserve was estimated at about 142.7 billion tones (in 2002),
of which OPEC was 112 billion tones.

Indian Scenario:
India ranks among the top 10 largest oil-consuming countries.
Oil accounts for about 30 per cent of India's total energy consumption. The
country's total oil consumption is about 2.2 million barrels per day. India imports
about 70 per cent of its total oil consumption and it makes no exports.

56

India faces a large supply deficit, as domestic oil production is unlikely to keep
pace with demand. India's rough production was only 0.8 million barrels per day.
The oil reserves of the country (about 5.4 billion barrels) are located primarily in
Mumbai High, Upper Assam, Cambay, Krishna-Godavari and Cauvery basins.
India had a total of 2.1 million barrels per day in refining capacity.

C} OIL & OILS SEEDS:


1} CASTOR OIL:
Introduction:
Castor oil is used as a raw material in the manufacture of a number of chemicals used in
the manufacture of surfactants, specialty soaps, surface coatings, cosmetics and personal
care products, pharmaceuticals, perfumes, plasticisers, greases and lubricants, and
specialty rubber etc.

Indian Scenario:

57

India is the world leader in castor seed and oil production and dominates the
international castor oil trade.

The Indian variety of castor has 48 % oil content of which 42% can be extracted,
while the cake retains the rest.

India's castor oil production fluctuates between 2.5-3.5 lakh tons a year. In 200304, India's estimated castor oil production was 2.8 lakh tons.

Gujarat accounts for 86% of India's castor seed production followed by Andhra
Pradesh and Rajasthan. Castor is mainly grown in Mehsana, Banaskantha and
Saurashtra/Kutch regions of Gujarat and Nalgonda and Mahboobnagar districts of
Andhra Pradesh.

Castor is a Kharif crop. The sowing season of castor is from July to October and
the harvesting season is from October to April.

The annual domestic consumption of castor oil in India is only about 80,0001,00,000 tons. Of this, the soap industry consumes about 25,000 tons, the paint
and allied industries 35,000 tons and the lubricant and derivatives industry 20,000
tons.

India annually exports around 2.0 - 2.4 lakh tons of commercial castor oil. From
India castor oil is exported in two forms - First Special Grade and Castor Oil
Commercial through mainly Kandla port.

World Scenario:
India is the leading producer of castor oil in the world, followed by China and Brazil with
0.8 and 0.4 lakh tons respectively. The present annual world trade in castor oil is
estimated at about 2.0 - 2.50 lakh tons. The major importers of castor oil in the world
market are European Union, US and Japan. The world demand for castor oil is estimated
to be growing at the rate of about 3 to 5 % per annum. Both Brazil and China have
experienced a steady increase in their domestic castor oil consumption in the recent years

58

and thus utilize almost their entire production. India consumes only a quarter of its castor
oil production and exports the rest.

Market Influencing Factors:

Variations in castor seed domestic acreage based on yield and price realization.

Crop development based on monsoon progress in key growing regions.

Chinese and Brazilian crop size.

Comparative price with other vegetable oils in the domestic market.

Upcountry demand of castor oil from the major cities, Export demand of castor oil
from US, Europe and Japan.

The castor seed price tends to firm up during the planting period and eases down
during the harvesting period. Prices tend to show inter-seasonal variation of
almost Rs 200 - Rs 350 per quintal.

Castor seed growers and crushers hoard the commodity before selling in
expectation of better prices. Castor oil too can be kept in containers without
spoilage for long period.

2} REFINED SOYA OILS:

Introduction:
Soybeans on crushing and solvent extraction yield soy oil at 18% recovery and
soymeal. About 85% is crushed worldwide.
Soybean and soyoil production of 170-185 and 25-31 million tons account for 5558% and 25-30% of global oilseed and oil production respectively.
US, Brazil, Argentina, China, India are the major producers in order of
production. In US, India, China crop starts arriving from Aug-Sept, while it starts
from Jan-Feb in S. America.
59

In the world 55-60, 8-10 and 42-45 million tons of beans, oil and meal are traded
annually.
USA (20-30 million tons), Brazil (12-18 million tons), Argentina (5-10 million
tons) are the exporters of beans, while China (18-20 million tons) and EU (15-18
million tons) are the major importers.
Argentina (3-5 million tons) and Brazil (2-3 million tons) are the major exporters
of oil. China (1.5-2.5 million tons) and India (1-2 million tons) are the major
importers of oil.

Indian Scenario:
India produces 5-7 million tons of beans, 1 million ton of oil and 3-5 million tons
of soymeal in a normal year.
With imports, the total oil availability in the country is around 2.5 million tons.
Madhya Pradesh (3.5-4.5 million tons), Maharashtra, Rajasthan are the major
producers of soybean in India.
The production is highly dependent on the monsoon and fluctuates between years.
Soy is a Kharif crop, sown in June-July and harvested by September-October.
Peak arrivals are from October-November.

Market Influencing Factors:


Weather at all the producing centers, domestic and international. The pod bearing
period, being the most crucial.
The area planted, determined by the price of soybean against that of competitive
crops, viz., maize, jowar, bajra.
International price movement, the futures market at CBOT being the major
international reference market.

60

Pests and diseases.


The supply-demand and price scenario of competitive oils, viz., palmoil.

D} CEREALS:
MAIZE:

Introduction:
Maize (Corn), is of American origin, and after wheat and rice, it is the most important
cereal grain in the world.
It provides nutrition to both humans (33.3%) and animals (66.6 %).
Serves as basic raw material for the production of starch, oil and protein, alcoholic
beverages, food sweeteners and more recently fuel.

61

Special crops grown primarily for food include sweet corn and popcorn, although
dent, starchy or floury and flint maize are also widely used as food. Flint maize is also
used as feed. Immature ordinary corn on the cob either boiled or roasted is widely
consumed.

Global Scenario:
World corn production in the year 2003 was 614.3 million tons while in year 2004
total world corn production is expected to be 642.6 million tons.
Major producing countries are United States, China, EU-25, Brazil, Mexico,
Argentina and India. These countries accounts for around 80 % of total world corn
production. Major consuming nations of corn are China and USA.
There has been continuous increase in the consumption demand of corn mainly owing
to increase in the demand from meat and starch sector. There is growing requirement
of maize from poultry sector, which uses corn as feed.
Major importing nations of maize are Japan, Korea, Taiwan, Mexico, Egypt,
Malaysia, EU and Colombia.

Indian Scenario:

India's maize production fluctuates between 10-14 million tons, with 80-90% of
the production being in the kharif season.

Major states that contribute in Maize productions are Karnataka, Andhra Pradesh,
Bihar, Punjab, Uttar Pradesh and Madhya Pradesh.

Around 6.5 million tons (roughly 50 % of total consumption) goes for feed use,
primarily for poultry feed. Another 1 million tons of corn is used by the starch
industry.

India is traditionally a maize importer, and Govt. permits a fixed quantity


(determined each year) to be imported at 15%. Extra has to be imported at 50%.

62

Factors that Affects Rice/Wheat/Maize Prices:


Role of weather in crop production is immense.. Further, natural calamities like
typhoon, floods, droughts and earthquake can also affect crops.
Changes in the minimum support prices (MSP) by the government also have
immense impact on the prices of the commodity.
Breakthrough in the technology may increase the productivity and would lead to
more supply. This may bring some softness in the price.
Breakthrough in the technology may increase the productivity and would lead to
more supply. This may bring some softness in the price.

Chapter 7
Conclusion
The future of commodity market:
A strong and vibrant cash market is a pre-condition for a successful and transparent
futures market.
As funds seamlessly flow from one market to the other and the Indian commodity market
begins to integrate with the global market, the risk perception is beginning to heighten.
Adoption of risk management or risk mitigation tools is now sine qua non for success in
63

businesses with exposure to commodities. A serious look at futures trading as a tool for
price discovery and price risk management is inevitable.
Before we examine commodities futures trading its principles and benefits it may
be worthwhile to crystal gaze into the future of this market. Some features of the
emerging scenario in India as far as the commodity market is concerned:
Expansion of commodity trade: Very clearly, trade volumes are set to expand rapidly.
Demand for a wide variety of commodities covering food, fibre, metals and energy is
certain to expand. India is likely to produce many of the aforesaid commodities, as
investment in production facility expands. If demand growth outstrips domestic supply
growth, imports will become inevitable. The possibility exporting certain commodities
also exists. In commodity production, consumption and trade, India will become an
important player in the international market. This will lead to a massive expansion in
commodity trade volumes over the next, say, 15-20 years.
Competition from imports: Whether or not domestic producers like it, the competition
from imported commodities is inevitable. This could be true in case of food crops, metals
and energy. In the short/medium-term, indigenous output will trail consumption demand
because of the lagged effect of investment. To fuel growth and rein in inflation, the
government and the business houses will have to resort to imports. As imports are
unrestricted (Quantitative Restrictions have been abolished), there will be liberal inflow
of goods from abroad. Often, imports from developed countries are low-priced and
subsidised. Such competition will result in inefficient domestic units falling by the
wayside, but will eventually lead to greater efficiency among domestic producers.
Role of MNCs: Multinational corporations cannot be wished away. They bring with them
a certain superior knowledge of operating in developing or emerging economies. They
also have deep pockets and, often, are long-term players. In the Indian commodities
sector, global companies will increasingly play a role as producers, suppliers, traders and
service providers. Indian producers will have to learn to face competition from MNCs.

64

Consolidation of fragmented capacities: It is well-known that commodity producers and


industrial consumers in India suffer poor scale economies because of their small size.
Fragmentation of business that is resulting in scale-diseconomies and other infirmities is
likely to give way to consolidation.
Competition is now driving smaller players to explore opportunities for merger. Bigger
companies with expansion plans follow the acquisition route. Mergers and acquisitions
will lead to consolidation of fragmented businesses, albeit slowly.
Dominance by a few large firms: In the developed economies, a handful of companies
share a big slice of the business pie. Typically, four-five companies would account for,
say, 60-75 per cent of aggregate business and several smaller players compete for the rest.
The commodity sector will inevitably move towards such a situation. The process of
consolidation and dominance by a few large firms is already visible, however incipient.
Take edible oil imports, for instance. Of the total imports of 45-50 lakh tonnes a year
worth over Rs 10,000 crore, five companies (of which two are MNCs) account for
roughly 70 per cent of business; the rest being shared by over 20 importers.
Waning role of government: As part of the economic liberalisation process, the
Government has not only freed the commodities market of controls and restrictions but
has also, by and large, distanced itself from the market. The interventionist role of the
government is now minimal. Of course, some restrictions still remain, like those on the
sugar industry.
The government's role is changing from controller to facilitator. It must, however, be
mentioned that "liberalisation is not licence''.
Use of information technology: Very clearly, IT will play a key role in bringing about
greater transparency in the commodities market. The country's strengths in IT will
increasingly be leveraged to connect stakeholders and link markets. IT will be used for

65

delivering price and market information to primary producers (farmers). E-commerce


will be the modern way of doing business. Several corporates have already begun to
employ IT to derive value, ITC's e-chaupal being a remarkable initiative. The agricultural
produce markets (numbering nearly 7,500 across the country) will soon be networked so
that growers can get to know prices prevailing in various marketing yards or mandis.
Strong cash market: These developments will result in a stronger cash market for
commodities. Initiatives are already underway to launch electronic spot trading in farm
commodities that will help growers and others not only discover prices almost real time,
but also help capture value by taking trading positions. A strong and vibrant cash market
is a pre-condition for a successful and transparent futures market. It is this emerging
scenario that market participants must gear themselves to face.

RECOMENDATIONS
1) It is observed that the commodity markets are upcoming market to watch for
investment.
2) Trading in gold will be more beneficial because it is more reliable as it is more
expensive.
3) Although investing in commodity markets is risky but a systematic & close study
of the markets before investing will make it more profitable.

66

BIBLIOGRAPHY
Published records:
Scott Wright, 21st Century Commodities Bull, February 3, 2006.
Manisha Gupta, Awaaz Commodity Editor, May 28, 2007.
Websites:
Money control.com

67

Sharekhan.com
Nseindia.com
Bseindia.com
Mcx.com
Ncdex.com
Finc.gov.in
Books:
The commodity market module [Ncfm]
Commodities Market - An Introduction Author(s): N Janardhana Rao
All about Commodities: From Inside Out by Wasendorf, Russell R

68